Question

Analyze how interest rates and inflation affect different investment instruments and investor decisions. Give specific examples from the New York Stock Exchange and the London Stock Exchange to support your answer.

For example, how do inflation and interest rates affect stock, bond, and mutual fund returns in each market? How does that, in turn, affect business and individual short- and long-term investment planning?

Answer 1

INTEREST RATES AFFECT INVESTMENT INSTRUMENTS

Interest rates directly have an effect on lending and borrowing as a result of higher interest rates create servicing loans a lot of costly. By changing interest rates, the Fed tries to achieve most employment, stable costs and a decent level growth. As interest rates drop, consumer spending will increase, and this successively stimulates economic growth which might spur inflation. The financial institution additionally desires to stay growth under control, since excessive economic growth will, of course, be quite prejudicious. At one extreme, an associate economy that's growing too quick will experience hyperinflation, resulting in the issues we have a tendency to mentioned earlier. At the opposite extreme, an economy with no inflation has basically stagnated and might expertise a deflationary spiral. the proper level of economic growth, and therefore inflation, is somewhere within the middle. It's the Fed's job to take care of that delicate balance. An adjustment, or rate increase, make an attempt to go off future inflation. An easing, or rate decrease, aims to spur on economic growth.

INFLATION AFFECT DIFFERENT INVESTMENT INSTRUMENTS

Inflation is dangerous news for savers because it erodes the buying power of your cash. low-interest rates additionally don’t facilitate, as this makes it even tougher to search out returns which will keep up with rising living costs.

Higher inflation also can drive down the price of bonds. These become less attractive as a result of you’re fastened in at interest rates which will not continue with the cost of living in years to come back.

One possibility is index-linked gilts, that are government bonds whose interest payments a price at redemption is adjusted for inflation. However, if they’re sold-out before their maturity, their value will fall also arise then is also more or but the redemption value paid at the end of their terms.

Investing in equities will potentially give higher protection against inflation than deposit accounts or bonds, that aren’t index-linked, as a result of firms will raise costs to cover higher prices. That, in theory, ought to change them to grow at the identical rate of inflation over time.

However, investing in equities carries a high risk of losses and you need to be ready to simply accept that you simply might come back to but you set in which the value of your investment might not continue with inflation.

Investors risk appetence in the rising interest rate scenario
Rising interest rate brings a couple of change within the manner investors understand risk and return. "From AN investors perspective, once interest rates rise, the risk-free returns go up because the bond certificate yields rise. Also, company bonds supply higher returns once the govt. yields increase. In such AN surroundings, investors can naturally choose the fixed rate of returns instead of an unsure and probably lower rate of return from equities.